Three ways to beat inflation

30 July 2013

With interest rates stuck at an all-time low and the rate of inflation rising, millions are seeing their savings and spending power eroded at an ever-growing rate.

Official figures released in June showed the rate of inflation, as measured by the Consumer Price Index, jumped from 2.7% in May to 2.9% in June, with price rises in air fares and clothing the largest contributors to the increase. While the Bank of England has a target of reducing the figure to 2% by 2015, the rate is forecast to hit 3% this year before any potential retreat.

As interest rates have been held at 0.5% for more than four years, the UK's banks and building societies have slashed saving rates. Savers now struggle to find a single standard savings account to match, let alone beat inflation.

Sometimes dubbed the silent assassin of savings, inflation marks a rise in the cost of everyday living as it devalues consumer spending power. In other words, the higher it rises, the less cash is worth and consumers have to spend more to purchase the same items.

A £10,000 lump sum put in a bank paying an average rate five years ago would be worth just £8,852 today for a basic-rate taxpayer, with inflation taken into account, according to Moneyfacts.

Anna Bowes, director at savings website Savings Champion, says: "Inflation is the saver's enemy. And this latest rise means savers have a truly bleak outlook in the war against it."

Driven by the search to negate the impact of inflation and boost their income, savers in their droves have turned to income-boosting alternatives, namely bond, equity income and commercial property funds. But the key for investors venturing into this route is to ensure they are comfortable with the potential balance of risk and reward and to look at not just one asset class but a combination.

Bond funds

Bonds are an 'I-owe-you' typically issued by either governments or companies looking to raise money. When an investor buys a bond, they are lending their cash for a set period of time. In return for the loan, the issuer pays interest to the investor and when the bond reaches maturity, the loan should be returned in full. Among the better payers are high-yield bonds, which are issued by companies deemed more likely to default on their payments, but they attract investors by offering a decent income rate.

Prices of bonds are sensitive to fluctuations in interest rates and inflation - generally dropping when inflation or rates rise - but investors can dilute the risk by investing in more than one bond via a fund.

This gives them diversification and ensures they are less reliant on the performance of one company or government. Strategic bond funds tend to be a popular choice among investors as they aim to deliver investors an above-average income, as well as the prospect of capital growth.

Patrick Connolly, a certified financial planner at Chase de Vere, tips the Henderson Strategic Bond and Jupiter Strategic Bond funds. He says: "These types of funds aim to deliver investors capital growth and income by investing typically in a mix of assets including high-yield bonds, high-quality investment grade bonds and government bonds. The Henderson fund is currently yielding a substantial 5.7% while the Jupiter portfolio is achieving 5.2% - both well ahead of inflation."

Their long-term performance is strong too. Over the past five years the Henderson portfolio has achieved a 57% return while Jupiter fund has delivered 71%.

Equity income funds

Investing in the shares of dividend-paying corporations (that is, firms which share their profits with their investors) is popular among income-seekers looking to beat inflation. Equity income funds, which aim to deliver attractive income and also capital growth, invest in such companies.

The share prices of regular dividend-paying firms tend to be less volatile than those of other companies; for example, Royal Dutch Shell and Vodafone are among the UK's bigger dividend payers. Longer-term equities tend to deliver better results than other asset classes, but potential investors should not focus purely on income as capital can fall in value. In addition, dividends can be slashed or pulled altogether if a firm finds itself in need of money.

The equity income funds will have a wide spread of investments to help buffer investors when company share prices fall out of favour.

Gary Potter, co-head of multi-manager at asset manager F&C Investments, rates the JO Hambro UK Equity Income fund. Currently, the fund is yielding 4.59% and over the past five years it has achieved a substantial return of 98% for its investors. Potter says: "The fund management team has a proven track record in delivering long-term capital growth and generating an above-average dividend yield."

Two funds that are regularly recommended by financial advisers are Invesco Perpetual Income, yielding 3.29% and Invesco Perpetual High Income with 3.16%.

Together, the funds house more than £20 billion of investors' cash and are run by Neil Woodford, one of the best performing fund managers in the UK.

Woodford has traditionally stuck with reliable dividend payers, such as tobacco and utilities stocks, and avoided following the crowd into more fad investment areas, such as the technology boom at the turn of the century. Over the past five years, the Income fund has delivered a total return of 53% while the High Income version has posted 56%.

For investors who wish to diversify further across dividend-paying firms, they could opt for a global equity income fund. Across Europe, the US and Asia, as well as in developing markets, there is an ever-growing emphasis on returning value to shareholders through dividend payments - global equity income funds are chasing this potential income.

Martin Bamford, chartered financial planner at Informed Choice, rates the Schroder Global Equity Income fund. The portfolio which has investments in the US, Norway, Japan, Singapore and the UK, presently carries a yield of 3%. Connolly rates Newton Global Higher Income, with a 3.99% yield. He says: "Newton is a very well-established income investment house and this fund provides good investor diversification."

Commercial property funds

Investing in commercial property - as opposed to buying it - gives investors the chance to spread their cash over a wide variety of properties, such as offices and retail parks, and the rents paid by tenants can provide a stable income. Up until six years ago, the asset class had been delivering double-digit annual returns and investors poured money into these funds. But when the credit crunch hit, they fell spectacularly out of favour.

The good years came to an abrupt halt in the summer of 2007; by July 2009, commercial property values had collapsed by more than 44%, according to the IPD UK Monthly index - the steepest decline it had endured since its records began. Given that bricks and mortar is an illiquid asset, in that selling a property can be cumbersome as opposed to selling a share, at the height of the crisis a number of funds imposed lock-in periods in a bid to stave off investor panic selling.

In the years running up to its collapse, commercial property was all about capital growth but, traditionally, it has been an income-based asset class and recently it has gone back to its roots, with their popularity gaining traction among income-starved savers.

There are two kinds of property fund: those that invest directly in bricks and mortar and those that invest in the shares of groups in the property sector, such as developers and hotel chains. Connolly says: "We do use commercial property but only recommend bricks and mortar, as property shares can be volatile.

But the asset class can provide a steady income stream and, while we are not particularly bullish about the potential for capital gains right now, investors can be looking at income above the inflation mark, at more than 4%."

Bill McQuaker, head of multi-asset investing at fund manager Henderson Global Investors, has recently increased his investments in the sector. He says: "Commercial property does not look too exciting an investment but if we can buy some, with a 4.5% yield, this will provide some inflation protection."

Recent performance figures for property funds are not covered in glory, with the average UK property fund down by 5% over five years. But this has picked up and, over three years, the average fund is up 13%. Bamford tips the Ignis UK Property fund, currently yielding 3.5%. He says: "This is a real bricks and mortar fund which means it is not going to be correlated to equities and, in addition, it has good geographical and industrial diversification across the UK."

Connolly cites the Henderson UK Property fund, which has a spread of direct property investments in areas such as retail parks and hospitals. It is yielding 4.5%.

All performance and yield data from Interactive Investor, as at 19 June 2013.

Expert tips on where you can beat inflation

Bond funds

Henderson Strategic Bond
Jupiter Strategic Bond

Equity income funds

JO Hambro UK Equity Income
Invesco Perpetual Income
Invesco Perpetual High Income
Schroder Global Equity Income fund
Newton Global Higher Income

Commercial property funds

Ignis UK Property
Henderson UK Property

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